2 for Tuesday: Taking a Stand for Ingersoll-Rand

The news that we're in a recession is old hat at Ingersoll-Rand (IR). As far as the company is concerned, the economy has been in a downturn for about four quarters already.

So although it's now a forgone conclusion that we're in a slump, things probably aren't going to get too much worse for Ingersoll. That's why it's a good time to look at the stock.

Industrial stocks typically bottom during recession periods; at least, that was the case in 1990-91 and 1981-82. Ingersoll-Rand is no exception. If you'd bought Ingersoll in November 1990, you would have earned an 86% return in one year, and if you held on to it until the end of 1993, you would have enjoyed another 50% gain.

In the last recession, Ingersoll-Rand's price-to-earnings ratio expanded throughout the year; by the end of 1991, a year when operating earnings declined 18%, the P/E was over 20. And even though the stock has made a big move in the last month alone, climbing 12%, it still trades at a P/E ratio of just 16.2 times 2002 estimates of $2.50, a big discount to its prior recession valuation.

Furthermore, Ingersoll was a much more economically sensitive company during the last recession, when its sales mix focused on mainly construction and mining equipment. Numerous acquisitions throughout the 1990s have broadened Ingersoll's business mix with market-dominating products such as Bobcat skid steer loaders and Thermo King refrigeration units, making the company more diversified, with an arguably more stable earnings base. If Ingersoll's P/E expands back to 20 on next year's earnings, this could be a $50 stock.

Though a good chunk of Ingersoll's sales mix faces challenging conditions in coming quarters, at least half of sales are in markets that are either turning the corner or are more resilient to the economic cycle. The heavy-duty truck sector is a good example. The stocks of some of the big truck manufacturers, such as Navistar(NAV) and Paccar(PCAR), are up 20% or more in the last month, suggesting that the truck market has hit bottom. (Indeed, this market has declined almost 50% from last year.)

Company Statistics INGERSOLL-RAND (IR)
Recent Stock Price:	$40.20
52-Week Range:	$30.40 - $50.28
P/E Ratio:	26.07
Market Capitalization:	$6.77 billion
Float:	134.7 million shares
Short Interest Ratio:	1.88
Institutional Ownership:	79%
Source: Yahoo! Finance

This benefits one of Ingersoll's largest and most profitable businesses, Thermo King ($1.2 billion in sales or about 13% of total sales), the market leader in refrigeration equipment for commercial trucks. Another $1.4 billion of Ingersoll's sales are from what the company calls its security and safety sector, which makes commercial and residential locks under leading brand names such as Schlage. This business has shown tremendous resilience, with sales relatively flat so far this year, and operating margins of 19%.

The business that faces one of the biggest challenges in the next few quarters is the bearings and components sector, which has about $1 billion in sales. Ingersoll's bearings are heavily tied to automotive end markets, where production rates are likely to remain under pressure. Through the first nine months of this year, sales have dropped almost 12%, and operating margins have been nearly cut in half.

Ingersoll is attempting to cushion its possible earnings shortfalls through restructuring. The current program, begun in the third quarter of 2000, is nearly complete. It includes the closure of 20 or more facilities and 4,000 job cuts, or about 8% of the company's workforce. These moves alone are expected to add another 25 cents a share to earnings in 2002 (which is already factored into analysts' estimates for next year). On the Oct. 18 third-quarter conference call with analysts, Ingersoll CEO Herb Henkel told analysts on the call that senior management is "reexamining our restructuring activity in light of the current economic conditions to identify further opportunities to permanently lower our cost base."

Revenue and Earnings Per Share
	Revenue	Earnings Per Share
1999	$7.667 billion	$3.40
2000	8.618	3.36
2001*	8.831	2.03
2002*	6.031	2.49
*Estimates from Thomson Financial/First Call Source: Company reports

In addition, the company continues to focus on strengthening its balance sheet, which currently bears a debt-to-capital ratio of about 49%. Ingersoll is focused on generating free cash flow to work off this debt. Working capital as a percentage of sales is down to 11%, with a goal of 10%. Capital spending has been slashed 30% this year to $170 million. Free cash flow should be $250 million this year, and potentially $350 million in 2002.

One event that will help both earnings and cash flow is the company's plan to move its place of incorporation from New Jersey to Bermuda. The plan is subject to a shareholder vote in December, but the company hopes to complete the move by year-end. Ingersoll expects to generate annual cash savings of at least $40 million through a 500-basis-point reduction in the corporate tax rate.

The hitch? This will be a taxable event for shareholders who may already have a gain in Ingersoll shares. Owners of Ingersoll stock on the day of conversion (which could be the last trading day of December) will be taxed as though they sold their shares that day, even though the stock will automatically convert into shares of Ingersoll Rand Limited.

The new shares will have a cost basis equal to the share price on the day of conversion. This may not be an issue if the stock does nothing between now and then, but it's definitely something to consider. Although $40 isn't a bad entry point into the stock, it has had a nice move in a relatively short time. So waiting for a pullback into the mid-30s might not be a bad idea, particularly in light of the share-conversion issue.

>To order reprints of this article, click here: Reprints